Home Depot Has Been Unfairly Left Behind by the Stock Market Rally

Home Depot shares have traded poorly since revising guidance in November. The share price consolidation is creating a potentially attractive opportunity for long-term investors.
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It’s becoming exceedingly rare to find high quality companies trading for attractive values in today’s market. It seems like every week we see new record highs and while this is great for investors who already have heavy equity weightings, I know that there are plenty of investors out there looking to put new capital to work. When looking for value in names that have sat out the most recent leg of the broader market’s rally, I came across blue chip name Home Depot  (HD) - Get Report.

For years, Home Depot has been considered to be the cream of the crop in the home improvement space, with a long history of generating stronger same store sales results, as well as higher margins, than its competition (namely, those of rival Lowes  (LOW) - Get Report). Because of this, investors have been willing to pay a premium for shares and it's a name that rarely goes on sale.

However, when management provided conservative guidance (which was disappointing to some) during its third quarter earnings report on Nov. 19, sentiment surrounding the stock shifted a bit. Since then, the broader market has rallied approximately 4.7%, while Home Depot shares have sold off to the tune of 7.5%.

Right now, Home Depot shares trade for just 18.2 times forward earnings estimates, below the S&P 500’s current forward price-to-earnings ratio. It’s rare that investors have an opportunity to buy Home Depot at a discount to the broader market’s forward earnings multiple and I think those looking to put long-term capital to work should consider Home Depot as an option.

Since its disappointing Q3 guidance revisions, many of Home Depot’s peers in the retail space have continued to rally as well. Yet, rather than chase the upward momentum that we’re seeing elsewhere in the market higher, I think it’s time for investors to take a look at a name like Home Depot that has been left behind.

Even though Home Depot appears to be un-loved by the market at the moment, the fact remains, this company is one of the most profitable names in the retail space. For instance, during the past five years, Lowe’s average annual gross margin was 34.08%. Lowe’s average operating margin was 8.22%. And, Lowe’s average net margin came in at just 4.4%.

During that same 5-year period, Home Depot’s average gross margin and operating margins were fairly similar, at 34.32% and 8.56%, respectively. However, when it came to net margin, Home Depot was the big winner, with an average of 13.86% compared to Lowe’s mid-single digit result.

Taking a step back and looking past the home improvement market and across the retail space as a whole, it becomes even more clear how impressive Home Depot’s profitability figures are.

When it comes to the biggest of the big box stores, Target  (TGT) - Get Report and Wal-Mart  (WMT) - Get Report, we arrive at 5-year average net margin figures of 2.84% and 2.52%, respectively.

And, in the un-loved department store space, the 5-year average net margin results of well known names, Kohl’s  (KSS) - Get Report and Macy’s  (M) - Get Report are actually better than Target and Wal-Mart's figures, coming in at 3.92% and 4.46%, respectively.

When looking at the 800-pound gorilla in the room, e-commerce giant Amazon  (AMZN) - Get Report, we see the lowest average net margin figures yet, at just 1.6% (and it’s important to note that these results are bolstered by the high margin Amazon Web Services revenues).

It’s not just the net margin figures that really shine when looking at a chart of Home Depot’s fundamentals. The company has grown its free cash flows from $6.8 billion to $11 billion over the last five years. Cash flow per share has risen from $4.74 in 2015 to $9.99 during the trailing twelve months. This latter figure also highlights the strength and effectiveness of Home Depot’s shareholder returns.

In recent years, Home Depot has invested in things such as automation, back-end technology, distribution, and maybe most significantly, itself via a robust buyback program. Since 2015, the company has retired roughly 17.2% of its outstanding share count. This share count reduction has had a significant impact on per share fundamental metrics, helping to create long-term shareholder value.

The company has also been generous with its dividend throughout its history. Management initiated its shareholder dividend back in 1987 and the company has been making consistent quarterly payments since then. Furthermore, management has increased the dividend for the last straight 10 years. Over the last decade, Home Depot’s average annual dividend increase was 18.8%.

While Home Depot’s debt levels have risen in recent years, up from $16.87 billion in 2015 to $26.6 billion today, the company’s standing with credit ratings agencies remains strong.

In short, when it comes to profits in the large cap retail space, Home Depot is tough to beat, which is why I think this is a name worth owning, even if the market has been content to ignore it during the most recent leg-up on the bull market rally. 

Home Depot is a holding in Jim Cramer’s Action Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells HD? Learn more now.